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High-Yield Bonds to Refinance Credit Facilities to Take Advantage of the Flexibility Afforded by Less Restrictive Covenants in High-Yield Bonds

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High-Yield Bonds to Refinance Credit Facilities to Take Advantage of the Flexibility Afforded by Less Restrictive Covenants in High-Yield Bonds KEY POINTS Feature The European high-yield bond market has seen significant issuances over the past two years (both in terms of number of issuances and volumes) and has seen numerous debut issuers. A driver of high-yield bond growth has been that high-yield bond covenants are typically incurrence covenants rather than maintenance covenants, not requiring the issuer to maintain any financial ratios. A number of bond issuers have used high-yield bonds to refinance credit facilities to take advantage of the flexibility afforded by less restrictive covenants in high-yield bonds. Authors James McDonald and Riley Graebner High-yield bonds: an introduction to material covenants and terms European companies with corporate ratings below investment grade are increasingly period, typically three or four years (in the case relying on high-yield bond issuances for debt financing, including for refinancing of a seven or eight year maturity) or five years existing debt, as well as for acquisition financing. The volume of European high-yield (in the case of a 10-year maturity bond) at the issuances increased by 53% in 2013 compared to 2012, with 174 issuers issuing 254 principal amount, plus accrued interest, plus new bonds in 2013. Growth in the high-yield bond market in 2013 was supported by a premium. The premium is typically equal 79 debut issuers, up from 40 debut issuers in 2012. Issuers in the UK, Germany and to between one half and three quarters of one France led the charge with e18.3bn, e15.3bn and e12.2bn, respectively, of issuances year’s interest payment in the first year that the in 2013.1 As high-yield bonds become an increasingly prevalent form of corporate bonds may be redeemed, with such premium financing in Europe, an understanding of the complex covenants that govern these declining each year following the first year the instruments becomes important for potential issuers and investors. This article optional redemption feature is available. sets out some of the key covenants and other provisions customary in European Floating rate bonds are typically redeemable high-yield bonds. after one or two years, at a call premium of 1% HIGH-YIELD BONDS: AN INTRODUCTION TO MATERIAL COVENANTS AND TERMS COVENANTS MATERIAL AN INTRODUCTION TO BONDS: HIGH-YIELD or 2% declining to 0% after one or two years. BASIC TERMS benefit from subsidiary guarantees (which “Equity claw” redemption High-yield bonds are fixed (or sometimes protect the bondholders from being structurally Within the first three years after the high-yield nfloating) interest rate securities, with subordinated to other creditors). bond is issued, the issuer can redeem up to 35% a fixed term typically between five and 10 An issuer may issue multiple tranches of (or, increasingly, 40%) of the high-yield bond years, and are generally issued to institutional high-yield bonds in the same offering, which using the proceeds of certain equity offerings investors. They are issued pursuant to an may include bonds in different currencies by the issuer. The redemption price is the indenture, which contains a number of (eg, euro and dollar tranches), with differing principal amount, plus accrued interest, plus a restrictive covenants applicable to the issuer maturities and with different ranking or credit premium equal to one year’s interest payment. and its “restricted subsidiaries” – which are support (eg, senior secured and unsecured When exercising the equity claw, there is a typically all subsidiaries of the issuer (the or subordinated tranches) and with different requirement that at least 65% (or 60%, in issuer group). High-yield bond covenants are interest rate provisions (eg, fixed and floating the case of a 40% equity claw) of the bonds generally “incurrence” covenants, regulating rate tranches). Where multiple tranches are remain outstanding following completion of the issuer group’s ability to take certain issued, the covenants are generally the same or the redemption, so to the extent that bonds actions (eg, pay dividends, incur debt, enter similar for all of the bonds. have already been repurchased or redeemed, into transactions with affiliates). High-yield that reduces the amount of bonds that can be bonds typically do not contain “maintenance REDEMPTION redeemed under the equity claw. covenants” requiring compliance with financial High-yield bonds will not normally contain any ratios on an ongoing basis, as is common with mandatory redemption provisions, although 10% redemption at 103% leveraged loans. The high-yield bond indenture there is a requirement for the issuer to offer to The high-yield bond may contain a redemption contains a number of exceptions to these repurchase the bonds in the case of a change feature which permits, at any time during restrictive covenants. The exceptions to the of control and certain significant asset sales. the first three years of the bond, the issuer restrictive covenants seek to strike a balance Fixed rate high-yield bonds typically permit to redeem up to 10% of the bonds in any between providing bondholder protection redemption of the bonds at the issuer’s option 12-month period by paying 103% of the (which can impact pricing of the bonds at in the circumstances described below. principal amount, plus accrued interest. issuance) and ensuring that the issuer has sufficient flexibility to operate its business. Optional redemption Make whole redemption High-yield bonds may either be secured or The issuer can redeem some or all of the The issuer can redeem some or all of the unsecured obligations of the issuer, and may high-yield bonds after the end of the non-call high-yield bond at any time prior to the time 242 April 2014 Butterworths Journal of International Banking and Financial Law HIGH-YIELD BONDS: AN INTRODUCTION TO MATERIAL COVENANTS AND TERMS COVENANTS MATERIAL AN INTRODUCTION TO BONDS: HIGH-YIELD Feature the optional redemption feature is available restrictions of the indenture covenants. Some Credit facility basket by paying the principal amount, plus accrued of the customary exceptions are described The issuer and restricted subsidiaries interest, plus a “make whole” premium. The below. For a number of the covenants, there are (sometimes limited to guarantors) will be able make whole premium is the amount of all specific “basket” exceptions, eg, credit facility to incur debt under credit facilities up to a fixed interest payments due on the high-yield bond or general debt baskets. More recently, in some threshold. This is an important basket as this is through the optional redemption date, plus indentures these baskets have “asset growers”, one of the few significant categories of debt that the first call premium, discounted to the eg, a basket may be the greater of €10m and can be secured. redemption date. a certain percentage of total assets (with the percentage set at the equivalent of €10m on the Permitted refinancing debt Tax redemption issue date). This exception permits the issuer group to If the issuer is required to pay withholding incur debt which is used to refinance debt in tax due to certain changes in tax laws after the Limitation on incurrence of debt existence on the issue date, permitted acquired issue date of the high-yield bond, the issuer and issuance of disqualified stock debt and debt incurred under the fixed charge can redeem the bonds by paying the principal or preferred stock coverage ratio test, as well as debt that has amount plus accrued interest. This covenant limits any incurrence of debt been incurred under the refinancing exception. by the issuer or its restricted subsidiaries. “Permitted refinancing debt” must meet certain RESTRICTIVE COVENANTS Disqualified stock (preferred stock which is conditions (eg, the new debt must not have a The indenture typically contains a number of mandatorily redeemable prior to the maturity maturity date prior to the maturity of the debt covenants restricting the actions of the issuer date of the high-yield bond) and preferred stock to be refinanced and the principal amount must and its restricted subsidiaries. All subsidiaries of any non-guarantor subsidiaries are treated as not increase). of the issuer will be considered “restricted debt for the purposes of this covenant. There subsidiaries” and subject to the covenants of is a separate covenant that limits liens, so even Acquired debt the indenture, unless the issuer designates a if an incurrence of debt is permitted under An acquisition of a company is deemed to subsidiary to be an “unrestricted subsidiary”. this covenant, that debt cannot be secured be an incurrence of debt of the acquired Subsidiaries can be designated as unless the security is a “permitted lien”, or in company. The acquired debt exception permits unrestricted subsidiaries at issuance or at a the case of a lien on collateral for the bonds, a the issuer group to incur debt of an acquired later time if certain tests are met. Unrestricted “permitted collateral lien.” There are a number company that becomes a restricted subsidiary subsidiaries are not subject to the restrictive of exceptions to the general limitation on debt (other than debt incurred in contemplation covenants of the indenture, but also do not incurrences. Set out below is a summary of the of the acquisition), provided that, after giving count towards net income and EBITDA most important customary exceptions. effect to the acquisition, the issuer would be of the issuer when determining debt and able to incur at least €1.00 of additional debt restricted payment capacity, except to the extent The fixed charge coverage pursuant to the fixed coverage charge ratio the issuer actually receives cash from those ratio test test or (in some high-yield bonds) the fixed subsidiaries. In addition, transactions between The issuer and restricted subsidiaries (in charge coverage ratio would not be worse than the issuer (or any restricted subsidiary) and some cases, limited to subsidiaries that are immediately prior to such incurrence.
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